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Who Makes Markets? Liquidity Providers Versus Algorithmic Traders
Author(s) -
Chae Joon,
Khil Jaeuk,
Lee Eun Jung
Publication year - 2013
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.21555
Subject(s) - market liquidity , warrant , profitability index , derivative (finance) , business , empirical evidence , monetary economics , economics , algorithmic trading , financial economics , finance , philosophy , epistemology
We investigate the roles of liquidity providers ( LP s) and algorithmic traders ( AT s) using a complete derivative warrant trading record of all investors in K orea. The main empirical findings indicate that LP s, the sole traders responsible for making market, do not trade primarily for liquidity provision. Instead, AT s provide liquidity. We further study the profitability of LP s and AT s and decompose their profits into information, market making, and mixed components. The results provide strong evidence that LP s earn profits using information about the future prospects of derivative warrants. AT s, however, are much better at sustaining profits by providing liquidity. Surprisingly, our evidence shows that though LP s earn positive total profits, AT s generally incur losses by trading. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:397‐420, 2013